While the term “debt” can make most Aussies cringe and run in the opposite direction, there are a number of ways you can use debt to your advantage and build wealth.
It may sound like the biggest oxymoron in history, but it’s true – if done responsibly and with the right guidance. Remember though, before taking on any debt you should always consult your financial advisor.
Bad vs good debt: what’s the difference?
With interest rates currently so low, Aussies are choosing to take out mortgages and loans more than ever.
According to the Australian Bureau of Statistics (ABS), in April 2021, new loan commitments rose by 3.7 per cent for housing, and 4.8 per cent for personal fixed term loans.
While still in the global pandemic and economic uncertainty, it seems that Aussies aren’t deterred from taking the financial plunge.
But how do good and bad debt differ and which one can support building the lifestyle you desire?
Let’s break it down.
Bad debt is often associated with things like credit card bills. This type of debt can quickly add up if you don’t pay it off within a particular period of time. Especially with the high interest rates and fees associated with credit card debt.
Then there’s good debt. This is defined as capital borrowed for assets or investments that have the opportunity to appreciate over time. This is anything from mortgages, student loans, home renovations or business capital.
How can you make this ‘good debt’ work for you?
Debt can often get a bad rap. However, if it’s managed well, good debt can allow you to make major purchases you otherwise couldn’t afford.
One approach is to try borrowing capital to invest in property or shares. Typically known as “gearing”, this can be a powerful tool to build wealth over time. It enables you to purchase a higher ticket investment than what might be possible with your savings on hand.
If your investment increases value over time, gearing can generate a higher overall return. This is after the interest, depreciation and other costs associated with the debt have been factored in.
Capital growth and income generated from the assets can also be used to pay back the debt, plus interest and fees. The interest charged on the debt may also be tax deductible.
Another approach is to consider debt recycling.
This is a strategy that aims to accumulate wealth over time by converting some of the debt which is inefficient (ie. doesn’t generate capital growth or income, or isn’t tax deductible), into debt that may be efficient (ie. generates capital growth or income and is tax-deductible).
One way this can use debt to your advantage involves using a lump sum, perhaps from a bonus or an inheritance, to pay off your inefficient debt. If you then borrow the same amount and invest it, you’re essentially repaying the inefficient debt with a debt that is tax-deductible and could potentially generate wealth.
High risk, high reward
It’s important to remember that there is a level of risk associated with an investment strategy that incorporates debt, however if managed correctly these approaches can help you be one step closer to building your wealth in the long term.
Different lenders including financial institutions and banks, neolenders, or non-banks like WLTH can also offer Australians great competitive rates on mortgages and home loans. Many are able to adapt offerings depending on each individual’s financial situation and risk appetite.
Have a chat with your financial adviser to see how you can use debt to your advantage when growing your wealth.